Comparisons between 2008 and 1978

Thirty years ago, the world economy was in the middle of a stagflation, a strange combination of high inflation and low economic growth. As a matter of fact, such period of stagflation lasted from 1974 to 1984 – ten years. This includes the United States, other industrial countries, and the great majority of the so-called (at that time) developing countries (later denominated emerging markets – since the nineties).

There were certainly exceptions for some specific countries, but in general the macroeconomic situation was terrible. Most of the economic analysts of that period attribute the stagflation of 1974-1984 to the double oil crisis (huge price increases in 1973 and 1979), as well as to the economic policy reactions taken by countries such as the United States, with double-digit interest rates under Paul Volcker. Almost as important: this ten-year period of stagflation succeeded a golden age of more than ten years – from 1961 to 1973, starting with John Kennedy and ending with Richard Nixon in the U.S.

Without trying to exaggerate the coincidences and similarities, we had another golden age period from 1992 to 2007, including now new players such as China, India and Russia. Is it possible that we are going to repeat what happened 30 years ago and start a long period of stagflation? The third oil crisis is already in process, with prices almost tripling in two years. But the interest rate levels are completely different – as well as inflation levels.

Given such similarities and differences, what can happen from 2008 to 2011, for example? For sure, some type of stagflation. But we have to confess that it is very difficult to analyze the potential bad behavior of growth and inflation in the next few years in developed and emerging countries. Particularly if we introduce as a footnote the fact that Barack Obama is courting Paul Volcker to come back to the economic policy game in the U.S.

When we say, however, that interest rate levels were totally different 30 years ago, we are talking about nominal levels. In real terms, it is not clear if interest rates were higher or lower in the seventies and eighties, as compared to 2008. Considering two good and opposite examples – United States and Brazil – the answers are entirely different.

Today, the US has a clearly negative real interest rate, and Brazil has the highest real interest rate in the world. The opposite was true in 1982, when Volcker led US rates to 16% per year, while Brazil started to face three-digit annual rates of inflation since 1980, against two-digit interest rates, although near 100%, as an authentic “race” between higher inflation and higher nominal rates (including the so-called Brazilian “monetary correction” or “indexation” at that time).

If we replace the general term “inflation” – which includes tradable goods, non-tradables and services – by some specific measurement of commodity price inflation, considering only some basic commodities such as oil, soybeans, corn, iron ore, etc., the problem of the “negativity” of real interest rates in the US and other industrial countries in 2008 clearly remains and it is probably even more serious. It is true that many commodity prices seem to have peaked recently, but there is no doubt that a carrying cost of 2% per year is entirely different from 16% per year. So, in spite of the impact of worldwide recessive trends on the overall demand for basic commodities, very low rates will continue to generate incentives for speculative attacks in favor of oil and soybeans, for example.

For all these reasons, it seems to be extremely useful to study carefully the seventies and the eighties, in order to understand what really happened then – and to try to guess what might happen in the next few years. This is the meaning of the title of our article: 1978 versus 2008.

However, there is a major question mark here, which is valid both for countries such as the US or Japan, as well as emerging markets such as the BRICs. One thing is to talk about positive or negative external shocks. Another thing is to analyze and try to guess the economic policy reactions in each different country to the external shocks.

This is normally the moment when the economist as a writer and analyst has a big difficulty to separate clearly his own opinion about what should be done in terms of economic policy from a cold analysis about what will be probably and really done by the policymakers themselves, as far as their actual economic policy is concerned.

Some analysts might believe that the US needs Paul Volcker and – surprisingly – even publications like “The Economist” said recently that the Brazilian Central Bank is the new Bundesbank. But, in practical terms – for fear of a major recession in both cases – the future President of the United States and/or the existing President of Brazil might not like and might not allow extremely restrictive economic policy reactions, particularly in the direction of higher and higher nominal interest rates.

And, frankly, at some point in time – just look at Brazil between 1981 and 1993 – raising nominal interest rates can be dangerous, particularly in an environment of increasing inflationary expectations. Because the economic agents might see precisely the opposite: a decline in real interest rates, in spite of higher nominal rates, due to a lost “race” between higher inflation and higher nominal rates.

As the song says: “We watch you watch us”. A new “law” in economics: there are Central Bank watchers, but the Central Bank watches the markets. Worse than that: in addition to a declining real interest rate, there starts a great volatility for real interest rates, which is terrible for real economic activity (and inflation) in general.

The major conclusion, when we compare 1978 to 2008, is that it will all depend on economic policy decisions in the next few months. But one thing is certain: just like we had a long period of stagflation from 1974 to 1984, after a golden age from 1961 to 1973, this is going to happen again. The golden age of 1992 to 2007 is over. We should be prepared for many years of going back to mediocrity: higher inflation and lower economic growth.

But major doubts persist: are we going back to double-digit inflation? To negative growth rates? This is what happened in 1974-1984.

We fear that we are going to repeat the seventies and eighties. But – perhaps using the old Pollyanna game – very few people would say that we are running the risk of a Great Depression – such as 1929-1933 in the US – or the risk of a hyperinflation – such as many European countries in the twenties (almost one hundred years ago), or Brazil more recently in 1987-1989, and again in 1992-1993. Cold comfort.

4 Responses to "Comparisons between 2008 and 1978"

Vitoria Saddi August 6, 2008 at 2:36 pm

Antonio Carlos,Great piece. My question is if you think that the slowdown in the world economy that might turn into a recession is something that can be attribute to business cycles or is something that was triggered by the US financial crisis?Thanks

Robert Fay August 6, 2008 at 2:38 pm

Do you think that Brazil will be as affected by this recession as it was in the past? Or do you think the country has better macro policies and hence may be in a better position to defend its currency and hence avoid a capital flight, for example?

Ana Martins Fontes August 6, 2008 at 2:39 pm

Don’t you think that this is the first recession that has been caused by the United States? Don’t you think that the reason for a recession makes a difference?

aNTONIOCLEMGRUBER August 7, 2008 at 2:51 pm

This comment is related to the three previous comments by Vitoria, Robert and Ana.Yes, business cycles exist. There is a new business cycle. People are going back to Hyman Minsky and others correctly. We feel that there is no such thing as Rational Expectations which was the base of the new classical school with Lucas, Barro, Friedman, McCallum and others.Brazil is certainly better prepared to face the new negative external shocks as compared to the 70s and 80s. But a few things have deteriorated such as the diversification of exports, the size of the Government, the tax burden, the bureaucracy. The supposed dynamism and drive of the Brazilian Economy – which was amazing between 1945 and 1985 – might be severely affected by this strange capitalism where the Government is growing fast.The correlation between world recessions and US recessions will always be very high although this does not say too much about causation.